Forget Germany, Spain is the real problem

25.09.2017 13:04

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Following yesterday’s German election, which despite Merkel’s 4th victory was a rout for the establishment “grand coalition” parties of CDU/CSU and SPD which saw its worst election performance since the 1940s offset by a surge in the ascendant right-wing AfD, there have been numerous analyst reactions to the “sudden reemergence” of populism in Europe, but one we find perhaps the most insightful and useful, comes from Bloomberg macro commentator Mark Cudmore, who writes this morning that for all the concerns, it’s not so much Germany as what is about to happen in European peer Spain, where Catalonia is set to hold an independence referendum on October 1, that should be on traders’ radars.

Below is his latest Macro View explaining why…

Euro Crisis Trading May Be Due for an Encore

The euro is once again set to suffer from an outsized political premium. Spain, rather than Germany, is the real problem.

The AfD’s strong performance in the German election and the lack of a clear coalition are both concerns at the margin, but they wouldn’t provide a sustainable headwind for the euro in isolation. Much more worrying is Catalonia’s planned independence referendum on Oct. 1. Investors have been ignoring this story, but this week will see it take center stage.

The heavy-handed response by the central government in Spain has significantly elevated the probability of civil unrest as well as potentially increasing support for independence for the region.

People opposed to breaking away probably won’t vote, so any poll that proceeds will return an unrepresentative and overwhelming result for independence. If Mariano Rajoy is able to snuff out the illegal referendum, it’ll only intensify the demands for another, more official independence vote. Failing to stop it means there’ll be a symbolic declaration of independence.

Either way, it’s probably going to lead to an increasing clamor for Catalan separation. The seriousness of the situation seems to have been overlooked by many investors, but it won’t be for much longer. The negatives are myriad.

Divisions within Europe are mounting again. Any success by Catalonia sets a dangerous precedent for other want-away regions, not just in Spain.

It emphasizes that many of the structural imbalances in the euro zone haven’t been fixed. Inequality is still growing.

On the back of AfD’s performance in Germany, it’s a reminder that large swathes of the population remain unhappy with the region’s policies. And once again, it’ll be an excuse for euro-bearish financial commentators to hype up the risk from Italian elections next year.

The beginning of the euro’s impressive rally coincided with Emmanuel Macron winning the French presidential election and thereby quashing political fears in the region. A correction in the euro is now likely to coincide with Spain and Germany bringing those risks back into the light.